Recent Investment Performance

It’s been a pretty awful 18 months now for investment markets.  When asset values fall, it is emotionally difficult and after a long period of weakness, it feels like it will go on forever and the best thing to do is bail on markets and move to cash.  That feeling is particularly strong when you can achieve interest rates on cash at around 5%.  At present, cash isn’t a ‘bad’ asset and we have higher levels of cash in lower risk portfolios than we’ve had in years, however it isn’t the solution, especially at this time in the cycle.  Despite the feeling of gloom and weakness in markets that has continued recently, the greatest opportunity is now.

Cash is an essential part of investing and planning.  Everyone should have cash for emergency purposes and can be part of long-term investment, however, now is not the time to solely invest in cash.

Increased long term interest rates   

The weakness over the last month has come mainly due to long-term interest rates rising in the US.  The 10-year US interest rate has moved from 3.75% in July to 4.75% yesterday, which is a huge increase for the usually sleepy long-dated government bond market.  It effectively makes the US dollar more expensive, which isn’t great for US consumers or the rest of the world.  Investors are seemingly believing the Central Bank mantra that interest rates will be higher for longer and that the US economy will perform better than expected.  This results in investors wanting higher compensation for lending longer.  If investors want higher compensation for lending to the US government, they will want higher compensation for everything.

Have short term interest rates peaked?

We think that short-term interest rates set by Central Banks have now either peaked or in some cases, very close to peaking.  This is the point in the cycle when you want to start locking in longer-term interest rates as it is likely that over the next year or so, interest rates will start to fall and the rates currently on offer will fall away.  This means that whilst cash has been the place to be over the last year or so, that will change and history shows that at the time of the last interest rate hike by the central banks, that bonds (i.e. locking in longer term interest rates) start to outperform cash.  The below chart from JP Morgan shows that when interest rates peak (black line), bonds start to outperform cash.

In the portfolios we have been investing into bonds extensively this year and continue to do so as the risk-reward opportunity is compelling.

What about other markets?

If interest rates have or are close to peaking, real assets such as infrastructure and commercial property should also start to perform well as they benefit from higher cashflows from their inflation-linkage.  These areas have been hit hard but as per bonds; the risk-reward is compelling.

Equity markets have been very mixed this year; the best performing companies have been very concentrated at the top-end of the US market.  We have more exposure in medium and smaller sized businesses where earnings growth has largely been flat over the last year despite large falls in share prices.  The below graph from Goldman Sachs shows different price returns (light blue) compared to earnings growth (mid blue) in different parts of cycle.  We think that we are in the ‘Despair’ part and will move to the ‘Hope’ part in the next six months or so.  That is when earnings fall, however, share prices rebound strongly on the hope of a recovery.

When asset prices fall, future returns increase so whilst it feels uncomfortable at present, the opportunity set is the biggest we’ve seen for a decade.  The environment for the next few years will be different to the recent past.  The income yields on lower risk assets mean that returns will be higher for these assets, which is why we have been investing in areas likes bonds.

Investing is emotional

The current environment naturally makes you want to sell when asset prices fall and invest when asset prices rise.  A big part of our job is to ensure we concentrate on investing for the longer-term.  Things will get better, and returns will improve.  We think that we are close to not only peak interest rates but also peak pessimism on areas like bonds, infrastructure, commercial property, UK equities and China and those that have a longer-term time horizon will be rewarded with returns significantly higher than cash.

If you want to hear more, we are hosting an investment event at the Leicester Space Centre on Monday 9^th October.  Please contact any of the team or visit our website to sign up!